Blog

There Will Be Rich Always: Finding a New Way to Think About Income Inequality

On Monday, Aaron Edlin and I published a cri de coeur op-ed in the New York Times calling for a Brandeis tax, an automatic tax that would put the brakes on income inequality. In the next few days, Aaron and I will be publishing a series of posts explaining more about our rationale and providing more details on how a Brandeis tax might be implemented.

The same is true of the rich. There will always be a top 1 percent of income earners. But what it takes to be rich can change drastically over the course of even a single generation. In 1980, you would have had to earn at least $158,000 to be a one-percenter; but by 2006 the qualifying amount had more than doubled to $332,000. (You can produce an estimate of your own household income percentile – albeit using a different definition of income that produces a much higher 1 percent cutoff – at this wsj.com site.) The rise is not due to inflation as both these numbers are expressed in inflation-adjusted, constant 2006 dollars. The rise is due to the simple fact that our richest Americans in real terms were earning much more money.

The economic changes in the past 30 years were a rising tide that did not lift all boats. Over the same period the median household income remained relatively constant, at roughly $50,000. While inequality has increased in most wealthy economies, the United States, according to the OECD, remains among the most unequal.

The vast shift in national income toward our richest 1 percent is especially vivid if their income is expressed in terms of the median household income. Indeed, an important goal of our op-ed was to suggest a new unit of measure, “medians” to help us think about what it means to be rich. In 1980, if you earned 3.8 medians, you were in the top 1 percent, but by 2006 even the poorest in the 1 percent club earned 6.9 medians.

What we call the “Brandeis Ratio,” the average income of the richest 1 percent (which includes the billions earned by the lucky few) has grown even more disproportionate. As shown in the chart below, in 1980, one-percenters on average made 12.5 medians, but in 2006 (the latest year in which data is available) the average income of our richest 1 percent was a whopping 36 medians.

Define Rich?

In August 2008, the Reverend Rick Warren asked each of the presidential candidates Barack Obama and John McCain to:

Define “Rich.” Give me a specific number. Where do you move from middle class to rich?

The candidates’ answers, given at what might be the high-water mark of income inequality in our nation’s history, reveals the difficulties that both parties have talking about economic class. McCain was visibly uncomfortable in naming a number:

So I think if you’re just talking about income, how about $5 million? So, no, but seriously, I don’t think you can — I don’t think, seriously, that — the point is that I’m trying to make here, seriously — and I’m sure that comment will be distorted — but the point is, the point is, the point is that we want to keep people’s taxes low and increase revenues.

In part, McCain was reluctant to name a figure which might be used to construct a new bracket to raise taxes – so he picked a large number; very large in terms of “medians.” McCain suggested that you would have to earn an income that is 100 times the median household income in order to “move from middle class to rich.”

Obama in contrast gave a much more reasonable answer:

Here’s how I think about it, and this is reflected in my tax plan. If you are making $150,000 a year or less as a family, then you’re middle class, or you may be poor. But 150 (thousand dollars) down, you’re basically middle class. Obviously, it depends on region and where you’re living. . . . I would argue that if you’re making more than 250,000 (dollars) then you’re in the top 3, 4 percent of this country. You’re doing well. Now, these things are all relative, and I’m not suggesting that everybody who is making over 250,000 (dollars) is living on Easy Street.

Obama should be given points for easily relating his cutoff of $250,000 to those Americans who are “in the top 3, 4 percent of this country.” But we are a little troubled at Obama’s describing family incomes of $150,000 as still being in the middle class, when these families earn 3 times what the median households earn. Survey data reveals contested definitions of middle class, and there is evidence that Americans disagree with Obama. In a 2007 study conducted by NPR, the Kaiser Foundation, and the Harvard School of Public Health, 51 percent of respondents did not consider a family of four with an $80,000 income middle class – that consensus rose to 65 percent when the family income rose to $100,000.

We as a nation seem to have trouble facing up to the fact that most Americans earn far less than what it takes to be comfortably middle class. We would do well to give more emphasis in our definition of the middle class to incomes earned by average Americans. Our aspirational middle class is making it too easy for us to forget what is happening to our actual middle class.

A larger goal of our op-ed is to spark a different kind of debate about income inequality. Rev. Warren was crafty in that he only asked the candidates the descriptive question: what is rich. But we want people of goodwill to ask a normative analog. In our op-ed, we claim that it “would be bad for our democracy if one-percenters started making 40 or 50 times as much as the median American.”

Is there any Brandeis Ratio that would give concern to this year’s Republican candidates? We suspect they would be unwilling to express unease with any level of inequality produced by market forces. They would argue that any government attempts to lean against inequality by taxing job-creators would invariably produce distortions (including sending one-percenters abroad, beyond the reach of our tax laws) that would end up making things worse off for middle class Americans. This is a debate worth having, but we cannot begin unless we find a way to engage in normative debate about income and wealth inequality. Asking whether the government should be concerned about the rapid rise of the average o
ne-percent income from 12.5 to 36 median incomes is our way to provoke a more explicit debate.

Seeing Medians

Framing income inequality in terms of “medians” is also part of a larger goal of making the median household incomes more salient. As we said in our op-ed, “Part of our goal is to change the way politicians speak about income equality. Framing the income of the wealthy in relation to the median income will help us all keep in mind the relative success of the middle class.”

It might even be useful to describe other things in terms of medians. A new Cadillac Escalade will run you 1.4 medians. A year’s tuition at Yale Law School is about .88 medians. We might even restructure government salaries so that they automatically adjust with the median. Paying a congressman 3.5 medians (instead of the current $174,000), might make it easier for our representatives to remember and even pursue the interests of their typical constituents.

To raise the prominence of the median measure, government could standardize a “mi” symbol. A stylized icon figure representing a median earner might even be more effective in letting us remember that to earn 36 median incomes is to earn as much as 36 actual households:

B.D. Warren

December 20, 2011 @ 2:41pm

So, would employers (who are presumably controlled by 1%ers) then not have the incentive to increase cash salary while at the same time charging employees for a much greater share of their benefits, thus inflating nominal income while keeping real take-home pay unchanged?

Clifton Griffin

December 20, 2011 @ 2:56pm

The problem with this analysis is that it doesn't take into account the people who move income brackets (i.e., income mobility).

See this link: http://mises.org/daily/5799/The-Rich-Arent-Dispossessing-the-Rest

There will always be rich. There will always be poor. They won't be the same people year in year out.

rationalrevolution

December 20, 2011 @ 4:55pm

Yeah, I mean who knows, next year Warren Buffet and John Pualson might be homeless....

Let's see Paulson is now 56 years old and took home $5 billion in 2010, so assuming that he just put all of it in cash under his.... well, under a mountain... using just his income from 1 year, with no new income, he could spend $100,000,000 a year every year for the next 50 years (assuming he lives to be 106 years old) before running out of money. Yeah, yer right, I doubt he'll "be rich again" next year...

K. Clark

December 20, 2011 @ 3:12pm

I frankly don't understand or agree with high executive pay. Talent is plentiful in the world and there is no reason to pay a CEO multiple millions. But, the answer is to put all the power into the hands of the stockholders. All of it. If they continue to make stupid decisions then, live with it.

But, one of my concerns with this question is that it is asked by academics. We're smart - why do they earn more than us? Because you produce nothing anyone wants. You have abilities, they just have no value. So the obvious solution is to use the power of the police state to steal it from someone else. The reality is that most academics are already vastly over compensated. Want to earn more? Build something. Create something. Something that people value and are willing to pay for. Everything else is stealing.

Mike B

December 20, 2011 @ 3:55pm

As much as you might be loathe to hear it most executives actually do earn their pay. Some are crooked, some are ineffective, but most of those that actually make a career of leadership have a set of skills that most people don't have. It is very very easy to sabotage a company through poor leadership. It is also difficult to succeed in a job where not taking risk is a recipe for failure, but taking the wrong risks is also a recipe for failure. The truth is that leaders so matter, just ask any professional sports team with a bad coach or general manager.

Also, modern information technology has made 'C' level executive far more valuable because they can be directly responsible for more decisions than was possible prior to the 1980's. Wherein a large mega-corporation like GM relied heavily on organizational unit managers back in the day, today the CEO is able to command the whole kit and kaboodle. All the pay that used to go to the Unit managers now accrues to the CEO. Look at Ford CEO Alan R. Mulally. He literally SAVED the company and prevented the loss of billions of dollars. Whatever the hell they are paying him it has been completely worth it. For the most part this isn't some conspiracy where a bunch of privileged insiders have found a way to scam the system. We simply live in a world where executive leadership skills have come to have a great deal of value. Today's large, highly complicated organizations simply wouldn't function without them.

Read more...

DaveyNC

December 20, 2011 @ 3:21pm

One of the reasons the evil rich/CEOs earn so much is that back in the '70's, Jimmah Cahter decided that there were too many people who made $1M in salary one year, so a new tax rate was instituted on incomes over $1M. It prompted the executive compensation specialists to develop other ways to compensate executives. What they came up with was our current system of bonuses and stock options. Even now, if you look at the salaries of the Fortune 500 CEO's, you will see that most of their salaries are right around $1M per year, give or take, but by far the bulk of their compensation comes from bonuses and stock options. Note the base salary in this report on page 2: http://origin.library.constantcontact.com/download/get/file/1102561686275-61/GMI_CEOPay2011_122011.pdf

So, Mr. Ayers, I imagine that they would like to be tossed into the briar patch once again. No telling what they would come up with.

Read more...

rehajm

December 20, 2011 @ 3:27pm

While this is yet another slice and dice of the income distribution statistics, the intended implications are the same- that because we can show 'growing' inequality that, despite the top earners acting legally, fairly and justly, their income is still somehow unfair and unjust, and a central planning government needs to intervene through taxation to 'restore' balance. I would propose it would be better outcome for all actors involved to recognize and accept that in a global marketplace for labor skills and scarcity of skills matters. Then, concentrate instead on those factors that contriblute class/income mobilty and work to improve them.

Sam_L

December 20, 2011 @ 5:08pm

rehajm,

Enron was legal, fair, and just? TARP money lent back to the government at a profit to subsidize bonuses was legal, fair, and just? Jon Corzine's handling of MF global was legal, fair, and just?

When the US government (through both parties) because complicit in handing out public dollars to private elite, we moved away from fair and just. And perhaps away from legal, although since the cronies are making the laws, they have found some ways to massage things there.

There are a myriad of problems - not least of which are American's no longer willing to put in an honest day's work - but don't pretend that corruption and complicity between the federal government and large corporations isn't part of the problem.

rationalrevolution

December 20, 2011 @ 3:39pm

*Sigh* so wrong...

#1 It's not simply about the dollar amount of income, its also about HOW the income is derived. Is it capital gains income or wages? I'd say that someone with $100,000 a year in capital gains income "is rich", yet I'd also say that someone with $100,000 a year in wage income is middle-class.

But look at what you do, you keep talking about "earning": "The rise is due to the simple fact that our richest Americans in real terms were earning much more money."

Err... no, they aren't "EARNING" more, what has happened is that there has been a massive redistribution of wealth and income from the working class to the capital owners.

Here is my question: Do so many people really have no understanding of capitalism anymore or do you guys intentionally obfuscate the issue?

Here is the truth about income inequality: There are TWO forms of income inequality: natural inequality and engineered inequality. To claim that all inequality is natural or that the only form of inequality is natural is to expose yourself as an obvious apologist of thieves.

Look, if you live in a neighborhood where one person (Johnny) goes around robbing houses every night and that person becomes the richest person in the neighborhood, simply saying "Ahh well there will always be inequality. The fact that Johnny is richer than everyone else is nothing we should worry about or be upset over. The fact that's he's richer than us does us no harm..., black, blah, blah...."

This is what you folks and all of the inequality apologists try to do, you try to pretend that we are all too stupid to understand that ummm... yeah, there are cases where the wealth of some is a product of theft from others.

Here is a fact: The super-rich aren't "earning" more money today than they did 30 years ago, they are stealing it all. Rather, they've engineered a system of massive "legal" redistribution, and over the past 30 years a larger and larger portion of the value created by workers around the world is being redistributed to the super-rich through capital ownership.

This is totally obvious of course. Capital ownership has become increasing consolidated over the past 30 years, that's a fact. The rise in incomes of the super-rich is a product of capital ownership consolidation, not of some small segment of the population becoming exponentially more productive. Capital has become consolidated and capital owners are getting a larger and larger cut of all value produced. That's what's happening, its obvious.

Yes, there is natural inequality, some people are naturally more capable, intelligent, hard working, and productive than others. However, the truth is that the "best" people are only naturally 2 to 5 times more capable or productive than average, so this doesn't account for situations where individuals have incomes hundreds of thousands of times greater than the average. No one is exponentially smarter, stronger, faster, or harder working than the average. If the average person works 40 hours a week, no one is working 40,000,000 hours a week obviously...

If the average person can chop down 5 trees in a day, a really productive person may be able to chop down 10 trees in a day, heck maybe even 15, but they aren't going to be able to chop down 500,000 trees in a day. Yet when we look at the income differences between someone like John Paulson and the average American worker, that's the kind of income differences that we see.

Those income differences are not a product of John Paulson creating 100,000 times more value than the average person, they are a product of billions of dollars of value created by average workers being redistributed to John Paulson, and yes, that means that we all have an interest in putting an end to his theft.

Calls to accept the levels of economic inequality we see in America today are akin to saying "We'll always have thieves, so just live with it and let people steal from you."

The super-rich ARE THIEVES, their incomes are NOT a product of value created by them, they are products of value created by everyone else (the working class). This has always been true and is remains true today. Exponential wealth concentration HAS ALWAYS BEEN AND ALWAYS WILL BE a product of exploitation. It was true of the Egyptians, true in Imperial China, true in feudal Europe, and it remains true today. The big lie is that the rise of democratic market economies" somehow magically changed all this, but of course it never did, think about how idiotic it is to believe that!

Read more...

Mike B

December 20, 2011 @ 3:42pm

While there will always be rich and poor, if the former does not at least make some modest effort to improve the lives of the latter there may be temporary periods where the number of rich may plummet dramatically due to the dual factors of needing spending a large part of their fortunes on security services and, when that proves insufficient, by being killed.

Brian

December 20, 2011 @ 3:46pm

You lost me at "cri de coeur" .... when your discussion begins with a phrase that let's say, only "1%" of people might understand - well, that is when I know the rest of the piece will be filled with high minded, self important babble.

I love Freakonomics. I have learned more here about how econmics works in the real world than my college classes. But this is nothing more than - dare I say it - class warfare.

Keep tilting at those windmills!

MrAtoZ

December 20, 2011 @ 3:47pm

I found the NY Times "cri" to be problematic on several levels, but here are three:
First, how is the IRS supposed to determine this ratio in a real-time basis if the most recent data available to make the case of the op-ed is 5 years old?
Second, if this is really how it's supposed to work -- "a tax that would limit the after-tax incomes of this club to 36 times the median household income" - are we really going to institute a varying marginal rate that could be 90%, or 99%, or 99.999% of income at that level?
And lastly, regardless of how the Brandies ratio is flattened, how does a confiscatory tax rate really help the median household?

Artie Gold

December 20, 2011 @ 3:53pm

On so many occasions things published under the greater Freakonomics banner, while certainly both thoughtful and thought provoking, tend to just tick me off. Fre

chris

December 20, 2011 @ 4:15pm

Why the focus on income? Income isn't wealth. Is it better to inherit a million dollars and work at the counter in fast food or be a doctor with a massive student loan?

Artie Gold

December 20, 2011 @ 4:19pm

On so many occasions things published under the greater Freakonomics banner, while certainly both thoughtful and thought provoking, tend to just tick me off. Frequently there's a tacit acceptance of "just the way things are", when it's really a specific human construct that they are -- for now -- that way. Sometimes I find a correlation/causation fallacy running just under the surface.

Not this time.

For once (well, more than once; after all I *do* read this stuff more than occasionally) there is an appropriately normative dimension surfacing here. I've often said that in our current situation *even it you're a true believer in the rightness of capitalism* (which, I'm not; on a good day I can at least subscribe to the "well, better than the others, when all is said and done" camp) you can't believe that the current level of inequality of wealth is a reasonable thing, if only because it makes the entire system unsustainable. As wealth concentrates, more demand is funneled into assets, and specifically into assets whose value is not related to productive capacity, exactly the kinds of assets whose valuation is the most brittle. And, when things get off track, large amounts of wealth goes "pfffft", those losses tend to be socialized, and we are where we are...

Of course, I would argue that 36mis is probably too much, I would also argue that the shape of the curve matters, and matters a lot (not to mention its fractal nature). Of course, were there "mi"-based taxation, ways would be found to raise the "mi" without raising the actual meaningful median income...but that's another issue entirely.

Eric M. Jones.

Here is the bad news…when the wealthy have all the power and the poor suffer, the economy spirals into undernourished diseased children on one end and overfed gout-afflicted plutocrats on the other.

Lest conservatives zombies chime in with their preprogrammed “You can’t penalize the job creators…” let me say, we all make the decision whether we are our brother’s keepers or not. If not, then prepare to reap the whirlwind bubela.

Arthur B. Kennickell of the Federal Reserve will (if allowed!) publish the real figures in the Spring of next year (I am told) and we may see that 50% of the wealth of the US is held by 1% of the people, and 50% of the people have 1% of the wealth.

But, what the Hell, the jails are full.

The way France solved this problem was to build a guillotine in every village square and chop the heads off 50,000 aristocrats. Let's hope we can do better.

Most people have NO IDEA what a Billion dollars is: What could one do with a billion dollars? A billion dollars is more than all the Alaskan gold mined in 2010—more than a cubic stack of gold bars 1 METER on a side. Just five percent of that billion dollars ($50 million) would get you: A lifetime lease on a Gulfstream jet at your beck and call. A home, condo or apartment in ten major exotic destinations, with a (leased) luxury fleet of cars at each, a coterie of servants to follow you around, memberships in every exclusive club, all you could possibly eat, wear, play with and see for the rest of you life. And Hell, throw in a yacht. Then you could sail around sipping expensive wines imagining ways to spend the other $950-million dollars.

Read more...

Enter your name...

December 20, 2011 @ 4:45pm

This seems to have completely ignored two major issues, which are the variations in household characteristics and the regional variations.

The "median household" is an adult with a $50K income. The "median family of four" has a $70K income and two children. Do we really want to tell that family that they're relatively well off, because they're supporting four people 140% of the income that someone else is supporting only one person (and with no childcare bills)?

If you're worrying about social issues, it makes more sense to compare the income of multi-person families against other multi-person families, and single adults against other single adults. It also makes more sense to compare people of similar ages. That's what we do in the real world. We don't look around at age 20 and say life is unfair because we're making only $40K a year and a worker with 30 years more experience is making $60K. We don't look at other families at school and say how great it is that most of us make more money than the single guy at the coffee shop. We're more nuanced than that.

Related to that, we compare against people in our actual social environment, not the whole country. It's a big country, and the regional differences are substantial. In my town, the median household income is more than $90K. In my grandmother's town, it's $40K. An income that puts you at the 85th percentile in my grandmother's town (and therefore relatively high-income) is barely middle of the pack in my town.

Read more...

Enter your name...

December 20, 2011 @ 4:50pm

"We as a nation seem to have trouble facing up to the fact that most Americans earn far less than what it takes to be comfortably middle class."

This is illogical. It is not *possible* for more than half of a population to earn less than the median, just like it is not possible for all of the children to be above average, even in Lake Wobegon.

The middle is the middle. Perhaps what you mean to say is that we as a nation seem to have trouble facing up to the fact that most Americans want a lifestyle that greatly exceeds what most Americans can pay for, and that we like to call that extravagant, television-fueled lifestyle "middle class" even though it is actually a more luxurious lifestyle than even wealthy people had before WWI.

Wm_Adams

December 20, 2011 @ 4:56pm

There's a real fallacy in your logic when you try to compare overall medians with the mean of the top 1%. I would argue that the mean of that 1% is greatly distorted by the top 0.1%. Why not use the median of the top one percent?

Your exception to the President's definition of 150k as middle class sounds logical, but I doubt that many who make sun a sum think of themselves as upper class or even upper middle class. While they certainly make more than the median, how people self-identify is a greater measure. Perhaps you should consider that the middle is the old lower class, the 3-4% is all that's left of the middle class, and the 0.1% is the upper class.